Chapter 20

Ten Reasons the West Should Pay Attention to Islamic Finance

In This Chapter

Predicting tremendous growth

Recognizing existing demand for sharia-compliant products

Gaining familiarity as Western institutions join the industry ranks

I congratulate you for holding this book in your hands. Some Westerners see the word Islamic and run away as fast as they can. My purpose in writing this book was to boost understanding among Western audiences not only of Islamic finance concepts and products but also of sharia principles and how they govern decisions (including economic decisions) Muslims make. With even a very basic knowledge of these concepts and principles, you can set yourself apart from the pack in a financial industry poised for growth.

This chapter offers ten good ways that your efforts in reading this book can reap long-term dividends — and why you should share your newfound knowledge with others who are working in (or planning to work in) the financial industry.

Islamic and Conventional Finance Can Coexist

Since the tragedy of September 11, 2001, distrust of Islam, sharia law, and Muslims in general has become the norm in some U.S. communities. The media has a habit of playing into people’s fears by running stories about interpretations of sharia law that lead to honor killings, suicide bombings, and other violence.

If you’ve read any other chapters in this book, you may already realize that the sharia code of conduct doesn’t, in and of itself, advocate such violence. Instead, the primary focus of sharia is the promotion of social justice. As with other belief systems, interpretations of source material differ. And the people who act on the most radical interpretations tend to be the most newsworthy.

A financial industry built on sharia compliance doesn’t threaten the Western world or seek to undermine conventional financial structures. Instead, it recognizes that for some people, especially (but not exclusively) Muslims, traditional banking, investment, and insurance products don’t fit the bill. Such products violate a code of conduct by which many Muslims strive to live, and so demand exists for new financial products that meet those folks’ needs.

A vibrant Islamic finance industry can and will exist in the future alongside its conventional counterpart. In fact, the Islamic financial industry will thrive in part because its conventional counterpart recognizes its value and makes an effort to participate in its success.

The Industry Is Poised for Growth

When I was born, the modern Islamic financial industry was still quite new. Since then, the industry has grown up and out to encompass new products, involve new markets, and attract many new customers. I expect the industry to mature in my lifetime, which means substantial growth will continue for many years to come.

As I note in Chapter 4, the global asset value of the Islamic finance industry in 2011 was estimated to be $1 trillion. By 2016, some experts project that amount to be $5 trillion — a huge increase. Predictions about the growth of Islamic finance institutions and instruments vary. Some say to expect 10 or 15 percent growth each year in the coming decade; others anticipate 30 percent growth per year or even more. Although the numbers differ, almost all industry experts are bullish about the Islamic financial industry’s outlook.

The Gulf Is Rich in Oil (and Cash)

A key factor influencing the optimistic perspective on the Islamic finance industry is the wealth concentrated in the countries of the Gulf Cooperation Council (GCC) — Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates. Almost half of the world’s oil and gas reserves are in the Gulf region, and although many governments are actively seeking to reduce their dependence on oil and gas, large-scale alternative energy projects will take time to develop. Meanwhile, oil and gas are energy mainstays.

Some of the world’s wealthiest countries and individuals are looking for sharia-compliant products in which to invest. A 2012 Trade Arabia article about the economic outlook for the GCC notes that while the U.S. economy tries to recover and Europe continues to struggle with its debt crises, GCC nations are liquid and well-capitalized. In fact, the article notes that determining how to safely invest extra funds in an uncertain economy is an obstacle for the region. As more sharia-compliant products emerge to fulfill customer objectives (including returns and liquidity), more Gulf wealth — more global money, period — will funnel into Islamic financial products.

The Muslim Population Is Large and Growing Quickly

From just 2008 to 2010, the global Muslim population grew from approximately 1.3 billion to 1.6 billion; that’s an increase of about 300 million people in just two years. And some people predict that it will jump another 35 percent by 2030 — nearly twice as fast as the non-Muslim population — to account for more than a quarter of the projected world population. If a reasonable number of those people seek out sharia-compliant financial products, the Islamic financial industry will soon be in high demand.

Although much of the growth will occur in the Asia-Pacific region, the West will see part of it as well. Projections in Europe, for example, indicate that the Muslim population will reach 58 million by 2030 (it was 44 million in 2010). In the United States, the population was 2.6 million in 2010 and is projected to reach 6.2 million by 2030.

Muslim Customers Want and Need Sharia-Compliant Products

Muslim population statistics represent real people who are a captive market of the Islamic finance industry — people with religious beliefs that drive them toward sharia-compliant products. I cover sharia compliance in detail throughout this book; basically, it means adherence to certain restrictions of Islam. For example, Muslims are prohibited from participating in interest-based transactions, gambling, creating or consuming products made from pork, supporting the creation of weapons of mass destruction, and more. Just this abbreviated list of prohibitions offers an idea of why sharia-compliant Muslims can’t put their money into conventional banks or purchase conventional investment instruments.

Muslims want and need financial products that offer the same types of rewards everyone seeks (such as security for their savings and rewards for their investments) without compromising their moral code. The global financial industry is paying attention to population projections and preparing to meet the needs of its future customers.

Non-Muslim Investors Notice, Too

When capital markets get as rocky as they have been since 2007, investors look to reduce risk while still earning a profit. Although no one can predict the future volatility or stability of Western markets, the lessons of 2007 and 2008 will stick with investors for quite some time. When products enter the market that offer the potential for increased portfolio diversification and reduced risk, customers take note.

Islamic investment products are very different from conventional equity and bond funds. (For a conventional investor, this diversity may be attractive.) As I explain in Part IV, Islamic investments are based on business contracts that increase transparency and reduce speculation so that all contract partners (including investors) know what to expect and what risks are involved. In addition, screening equities for sharia compliance includes looking closely at companies’ financial ratios to eliminate those that, say, carry too much debt.

The end result of such diligence on the part of Islamic fund developers is that sharia-compliant investment products often involve less risk than their conventional counterparts. (Note that I say less risk; sharia compliance doesn’t eliminate risk.) For this reason — and because knowledge of the industry itself is growing, especially among the world’s wealthiest investors — I believe that Islamic financial products will attract even greater numbers of non-Muslim customers in the future.

Socially Responsible Investing Is Thriving

Sharia law promotes social justice, and sharia-compliant investments are a subset of a larger trend: socially responsible investing (SRI). As I note in Chapter 11, SRI is a broad term that refers to making investment choices in support of companies whose activities mesh with your values.

Investors who seek out SRI must do their homework before making decisions about where to place their money. SRI requires transparency from investment funds because investors don’t want to unknowingly support industries they oppose. Therefore, fund managers must consistently screen companies to determine whether (in their core business or any subsidiary business) the companies participate in activities the investors want to avoid. In other words, socially responsible investors look for fund managers to do exactly what Islamic fund managers already do.

According to The Forum for Sustainable and Responsible Investment (ussif.org), in 2010 more than $3 trillion in total assets (including $1 out of every $8 of professionally managed U.S. investments) were being sustainably and responsibly managed. As public knowledge of Islamic investments grows, I anticipate that investors (including non-Muslims) who are already seeking out socially responsible funds will increasingly find that sharia-compliant funds meet some of their investment needs.

Western Indexers and Rating Agencies Are in the Mix

The emergence of Islamic indexes is a huge industry development (see Chapter 12). The first player in the Islamic indexing field was none other than Dow Jones Indexes, and it has been joined by Standard & Poor’s, FTSE, and MSCI. The result is that Western investors have access to benchmarks that track the performance of the Islamic finance industry in ways that are familiar and build confidence.

Similarly, Western investors who consider purchasing sukuk, the Islamic alternative to conventional bonds, can now compare sukuk by using the ratings systems so familiar to bondholders (see Chapter 13). The Dow Jones Sukuk Index, created in 2006, was the first of its kind. And Standard & Poor’s, Moody’s, and Fitch now all rate sukuk products by using the same ratings systems they use for conventional bonds. Familiarity with these agencies and the tools they use to communicate the strength and risk of bond products gives Western investors confidence and comfort, which will undoubtedly lead to greater participation in the Islamic capital markets.

London Is Leading the Charge

Just as having Dow Jones Indexes and Standard & Poor’s involved in the Islamic capital markets may comfort Western investors, so may the knowledge that one of the world’s largest centers of Islamic finance is London, England. With about two dozen British banks providing Islamic finance services, managing approximately $19 billion in assets as of 2011, the nation’s Islamic finance sector ranks ninth in the world. A natural extension of this market’s size is that more education outlets offer Islamic finance training in Britain than anywhere else.

Certainly, many more Muslims live in Europe than in the U.S., so the captive market for Islamic financial products there is much larger. But Western financial professionals as a whole can’t ignore the size and growth of London’s Islamic banking sector. Britain’s role as an industry leader demonstrates how effectively Islamic and conventional financial systems can coexist and support each other. And I think London’s example will influence other Western nations to develop their own Islamic banking industries.

Globalization Is Here

In the past, most companies could build a solid business just by serving or distributing products to a local, regional, or national customer base. These days, companies of all sizes can easily seek customers across the globe, and doing so has become a matter of survival. Western financial firms certainly recognize the need to tap into global markets, and technology makes it simple to transfer assets quickly among institutions thousands of miles apart.

The financial institutions that succeed in the new economy will be global entities that meet the needs of customers in every major market; many of those customers will be Muslims seeking sharia-compliant products. Governments that recognize this fact and want their financial sectors to thrive will alter their monetary policies to accommodate Islamic financial practices.

This process is already underway in some Western countries, including the United Kingdom, France, Germany, Luxembourg, and Russia. No matter how many misconceptions about sharia proliferate, businesspeople understand market share. It’s only a matter of time until the sheer size of the Islamic financial market prompts regulatory changes in other Western nations. (See Chapter 4 for regulatory and tax barriers to Islamic finance.)